Earlier this week Econlog and Marginal Revolution had a good discussion about an article by
Terry J. Fitzgerald in the Minneapolis Fed Review.
The article goes into a great deal of detail about the weak performance of average hourly earnings in recent years.
One point in the discussion was the new experimental measure of average hourly earnings being developed by the BLS. This measure has been getting a lot of attention lately with the widespread expectations that the new measure would show that the old measure of average hourly earnings has been significantly understating the rate of gain for average hourly earnings.
We now have some 16 months of results from the new experimental measure of average hourly earnings. it shows.
In the first year the new measure grew 3.3% while the old measure expanded 4.0% and over the first 16 months the old measure of average hourly earnings grew 5.4% as compared to a 4.3% increase for the new experimental measure.
So far it looks like the new experimental measure is demonstrating just the opposite results that what was expected by those who believe that average hourly earnings has been significantly understating the income growth of the about 80% of employment that punch a time clock rather than earn a salary or commission or are self employed.
There is a widespread belief that the destruction of industry in Japan and Europe played a major role in US economic growth in the 1950s. While the war time destruction did play a role in the lack of competition in the 1950s, the data says that it did not make a significant contribution to real GDP growth. If you look at the real trade contribution to real gdp growth you find:
Since the early 1980s the
has experienced only two minor recession. It appears that the
Generally, three or four main factors are credited with this change.
One is the improvement in information technology so that firms no longer make the inventory errors that generated recessions. One example of this was just completed. Last fall firms started to accumulate unwanted inventories as the inventory/shipments or sales ratio started rising. In the old days this would have lead to a major inventory accumulation that was followed by a sharp drop in output or a recession as firms finally liquidated the unwanted inventories. But this time firms reacted very quickly and liquidated the unwanted inventories before the problem became so severe it caused a recession rather then just a slowdown.
The past year’s inventory correction also demonstrated a second cause of the great moderation–the growing importance of international trade. In the old days if a retailers wanted to cut inventories it would cut back orders to a domestic manufacturing firm and that firm would have to cut output and lay off workers and this generated a negative Keynesian multiplier. Now, a great portion of the drop in orders is to
A third factor is a lack of shocks. Much of the poor economic performance of the 1970s was blamed on the oil shocks so the absence of such oil shocks was credited as part of the reason for the great moderation. But recently we have experienced another oil and commodity shock and it is not generating a recession as it did in the 1970s. Consequently, the luck or shock explanation for the great moderation is fading away.
Tightly tied into the impact of shocks or luck is the fourth factor explaining the great moderation is improved productivity. In the 1970s productivity was poor and unit labor cost rose so much that firms had little choice to pass through the higher oil and other commodity prices. But this cycle productivity has been so good that firms could absorb much of the higher oil and commodity prices and still sustain strong profits.
The final factor used to explain the great moderation is better policy, especially better monetary policy. As far as fiscal policy is concerned there was a significant policy shift in the early 1980s from tax cuts or deficit spending to stimulate demand to tax cuts or deficits to stimulate supply. Does demand create its own supply, or does supply create its own demand? For monetary policy it looks like the shift was from policy rules that gave inflation and unemployment roughly equal weight in determining policy to policy rules that gave fighting inflation a much greater weight.
So how do we evaluate these changes. Roughly, we have traded-off having frequent, severe recession for having much less frequent and milder recessions and lower inflation for about a 0.5 annual percentage point slowing of trend real GDP growth or about 0.25 percentage point weaker per capita real GDP growth So what does this look like. Maybe comparing actual real GDP to potential real GDP is one way to make the comparison. Potential real GDP is a measure of capacity calculated by the CBO based on growth in productivity and labor force. Thus, real GDP is a % of potential GDP is a measure of capacity utilization, or of actual economic performance relative to
As the chart shows there was a major structural shift around 1980. Prior to 1980 actual real GDP was above potential real GDP almost two-thirds of the time while since 1980 it was only above potential about 2.5% of the time. It is like the old Army recruiting slogan, “Be All You Can Be”. Before 1980 it looks like the economy was “ All It Could Be” while since 1980 it has been “Less Than It Could Be”. Moreover, since 1980 as we experienced much more idle resources real potential GDP growth also slowed significantly as the following chart shows. The chart has two trend lines. A straight line for productivity pessimist and a curved line for productivity optimist.
When I look at these charts I reach a couple of conclusions. One, it looks like the difference in the pre-1980 era and the post-1980 is that the shift in monetary policy to giving inflation a greater weight than employment worked through the mechanism of creating sufficient excess capacity in the economy—a form of Phillip Curve analysis . Second, in contrast to supply-side policies Keynesian demand management worked to generate too strong an economy before 1980.. But since1980 supply-side policies have massively failed to stimulate strong economic growth. Of course, there are other explanations. One is that the strong economies of the 1950s and the 1960s was due to the stimulus and demands stemming from the Korean and
Otherwise, I’ll just leave these comments and charts as the start of a good discussion.
There was a discussion of Greenspan as a Fed Chairman earlier today.
Different people were making various claims with no evidence to support their positions.
So I though I would put in my two cents worth, but provide a chart to show why I take the position on Greenspan I do.
The first chart is my Fed Policy index. It is my version of the
difference between my version and other versions is that this one gives inflation and
unemployment equal weights. Most
This version says that Greenspan started office by tightening more then was necessary as in the late 1980s actual funds were higher then the rule implies they should have been. This obviously contributed to the 1990 recession.
But the index implies that through the 1990s Fed Policy was almost exactly what the index called for. In other words we could have programmed a computer to give us almost exactly the same policy that Greenspan actually produced. Maybe the more interesting question is, if Greenspan followed the same policy rules as pre-Volker Chairmen had, why did it generate such different results. This clearly implies that K Harris is correct to think that much of what Greenspan achieved was strictly a matter of luck. Or maybe it was the lagged impact of the unusual tightly policies Volcker implemented. But again in the early 1990s actual policy deviated from the policy index as policy was significantly more expansionary then the index implied it should have been. We are still not certain if that was the best policy.
In this chart I simply did a regression of actual funds against the index and a dummy variable for Volcker. It is just another way of showing that through the 1990s Greenspan
did almost exactly what my policy rule called for.
Productivity growth is clearly slowing, and the key question is, is this a purely cyclical development or is it signaling a slowing in the long term trend growth rate.
Slowing productivity is a normal cyclical development and it is such a strong pattern, that historically, it has been a very good leading indicator. But this implies that we can not really determine if the recent slowing is just cyclical weakness or a trend shift.
To answer this question we need to look at indicators that either lead or determine productivity growth. It is a question economists have been researching for years
But clearly a major factor in productivity growth is the real capital stock per worker and it is generally widely accepted that this accounts for a quarter to half of productivity growth. Moreover, it also leads productivity growth by about a year.
There is also a long term relationship between trend productivity growth and trend growth in the real capital stock per workers as the following chart demonstrates.
From WW II until the late 1970s, early 1980s there was a very strong and relatively stable trend growth rate for both productivity and real capital stock per employee. But in the 1980s economic cycle growth in the real capital stock per employee stagnated, as it was still the same in 1990 as it had been in 1982. There was a cyclical bump in the early 1990s but this was driven more by a drop in employment then by stronger investment. With the capital spending boom of the late 1990s growth in productivity and the capital stock per employee surged again. But in recent years growth has stagnated again as since the Bush tax cut it has failed to grow.
This data on growth in the real capital stock per employee strongly implies that the recent slowing in productivity growth is not just a cyclical slowdown. Rather it looks like a shift to a slower growth trend driven by weak capital spending.
Obviously, given the limitations of blogging I can not get into much of a discussion of why growth in the real capital stock per employee did not grow in the 1980s or in recent years. However, these results are exactly the opposite of what the advocates of supply-side economics or republican trickle-down policies have promised. Maybe the simple answer is that there is no significant relationship between tax policy and capital spending.
But on the other hand since WW II the
In looking at the question of whether business or government is more wasteful it might actually be possible to use the pro-business argument to demonstrate that business is actually more wasteful.
The argument is that government does not have competition to force it to quit doing something so it continues to do things when they are no longer needed. I agree it is a valid argument.
The argument continues that competition forces inefficient firms to close down and they commonly cite examples of bad firms like Enron or Countrywide to document their case.
But they make their case with a few examples and virtually never look at aggregate data.
There was a study in the BLS monthly Labor Review of May, 2005 that actually looked at this issue.
The looked at how new businesses survive. They found that 33% of new business fail in the first two years and 56% fail within four years. I’ve heard these types of numbers cited for restaurants, but this study found that there really was no significant difference between the failure rate for restaurants and other industries.
The study also looked at other studies of the survival rate or exit rate for established firms. The studies they cited found that for established firms about 50% go out of business every four years and over 60% exit every five years.
The numbers are not exactly comparable, but the BLS study found that roughly 20% of US firms close down every year. That has to be a tremendous misallocation of resources. Remember, these will generally be smaller firms. But it is like the data on job creation. You hear all the time that small firms create most jobs This is true, but they also destroy more jobs so that over time their share of employment never seems to grow.
So what we are looking at is that government is wasteful because competition does not force it to quit doing some things. But on the other hand having some 20% of US businesses closing down every year also seems to be very wasteful. I’m deliberately using the term wasteful, not efficient because efficiency and wastefulness are not exactly the same thing.
On balance I do not how to make a meaningful comparison of these two phenomena. One reason is that I have no estimate of how much of government should be closed down.
So I have no idea whether the private sector or government is more wasteful. But I doubt that very many of the individuals making the case for private business not being wasteful are really aware how wasteful private business really is even though hand having 20% of US businesses closing down every year may be highly efficient because it is the best we can do.